BIR RULING

No. [DA-ITAD 68-08]

23 May 2007

Facts:
Insular Life Assurance Co. (“Insular Life”) , a Philippine corporation engaged in the insurance
business, and LIDP Consulting Services Inc. (“LIDP”) , a non-resident foreign corporation
engaged in consulting services for data processing clients, entered into a License Agreement
whereby LIDG granted to Insular Life a license to use its proprietary software systems. The
License Agreement provides that Insular Life shall pay license fees to LIDP as consideration for
the grant of the license.

Insular Life argues that the license fees should be considered as royalty payments and should
therefore be subjected to the 10% income tax rate applying the most-favored nation clause (using
RP-Germany Tax Treaty) under the RP-USA Tax Treaty.

Issue:
Whether the license fees paid by Insular Life to LIDP are subject to the 10% income tax rate
pursuant to the RP-USA Tax Treaty.

Ruling:
1. Under RMC 77-2003 which applies to software payments made before September 8,
2005, “royalties” have been defined as payments of any kind received as a consideration
for the use of, or the right to use, any copyright of literary, artistic or scientific work, or
for the use of, or the right to use, industrial, commercial or scientific equipment, or for
information concerning industrial, commercial or scientific experience.
2. Under RMC 44-2005 which applies to software payments made on or after September 8,
2005, software payments are treated as royalties only if the transaction does not constitute
a sale or exchange and not all substantial rights in the software have been transferred but
merely copyright rights in the software. However, if a person acquires a copy of a
software but does not acquire any of the copyright rights in the software, and the
transaction does not involve the provision of services or know-how, the acquisition is
treated as a transfer of a copyrighted article only and payments for it constitute as
business income and not as royalties.
3. Based on the aforementioned definitions, the license fees paid before September 8, 2005
are treated as royalties while those paid on and after September 8, 2005 are treated as
business profits.
4. On license fees considered as royalty payments, the 10% income tax rate under the RP-
Germany Tax Treaty is not applicable. Article 13 of the RP-USA Tax Treaty provides
that the lowest rate of Philippine tax may be imposed on royalties of the same kind paid
under similar circumstances to a resident of a third state. The RP-Germany Tax Treaty
provision on tax on royalties, however, do not fall under similar circumstances as that of
the RP-USA Tax Treaty.

For the United States, it uses the ordinary credit method whereby the United States would
limit a taxpayer’s allowable tax credit to that portion of the taxpayer’s tax liability in the
United States that is attributable to income that was taxed in the Philippines. Germany, on
the other hand, applies a tax sparing credit method.
 Using the most favored nation clause of the RP-USA Tax Treaty, the BIR applied the
15% income tax under the RP-Netherlands Tax Treaty.

5. License fees paid after September 8, 2005 are treated as business profits as LIDP did not
grant Insular Life the copyrights of the software. Under Articles 5 and 8 of the RP-USA
Tax Treaty, the license fees are subject to Philippine income tax only if they are
attributable to a permanent establishment. LIDP, being a non-resident foreign corporation
without any branch or subsidiary in the Philippines, does not have a permanent
establishment, and is therefore not subject to income tax.
6. The license fees are also subject to the VAT consistent with Section 106(A) of the Tax
Code.